Growing a business is most associated with increased revenues or services. However, entrepreneurs should also consider the appropriate legal structure for a business opportunity. Due to low cost and convenience, many start-ups begin as sole proprietorships or partnerships. While this setup may be suitable for basic operations; your staffing, liability and tax needs may benefit from incorporating. So, how can you tell if a new or existing business should be incorporated?
Below are some factors that could affect your decision:
You Have Added Employees:
Hiring employees can signal successful growth. You are making an investment in productivity and expanding operations to serve more customers.
Although these are positives, you should consider the liability that accompanies hiring a staff. Experienced entrepreneurs such as Elliott Broidy and new owners alike benefit from limiting risk exposure. Employees that commit illegal acts or inflict damages on customer property can expose you to lawsuits. As a corporation, you have limited liability to the unlawful or harmful actions of staff members. If you have staff that work alone or with minimal supervision, forming a corporation can buffer against this risk.
Separate Your Personal and Business Assets:
A corporation is a distinct entity that separates your personal finances from business operations. Many sole proprietors or general partners finance their businesses with credit cards and personal means. In cases where business obligations cannot be met, creditors can pursue individual assets. By incorporating, your estate is protected in case of the business failing. Legacy-The Business Will Continue With or Without You:
Corporations survive if owners die or are incapacitated. Conversely, sole proprietorships cease to exist upon the ownerâ€™s demise or decision to step aside. Similarly, a partnership dissolves if an owner leaves. This can pose challenges for those who want the business to continue, even if they are no longer involved.
Despite improved protection against lawsuits and other liability, corporations can face higher taxes. Instead of personal income tax rates as a sole proprietor, you are first taxed at a corporate rate. Need to draw income from the net amount? Personal tax rates are then applied to this distribution, which creates a double tax. Forming an S Corporation or Limited Liability Company (LLC) helps avoid this double taxation. Each of these is a pass through entity, meaning income paid from the business is levied at your personal tax rate.
Your Cash Flow is More Complicated:
Many business start-ups have basic cash flow models. Revenue is earned and expenses are paid mostly on demand. When your business grows to have items such as accounts receivable or depreciation expense, professional accounting help may be needed. At this point, some sole proprietors may not have the savvy or resources to prepare their own taxes.
Sole proprietors (SPs) are at particularly high risk of IRS audits. Since SPs blend personal and business taxes, there is more potential to misreport income or deductions. Although audits are random, incorporation may remove a prime warning signal for the IRS. Working with a tax professional also provides insights on other strategies that are not readily apparent.
Summary-Evaluating Your Business:
Business needs are dynamic. Each opportunity has unique factors, but taxes and liability are common considerations. Reviewing your business regularly gives a better perspective on what legal structure is most beneficial. Please consult with a CPA or legal professional as needed.